Oil prices have risen by more than $20 in the past year, giving rise to adjustments that will affect the global economy for years to come. The question is, should companies react as if the change is permanent, or delay in the hopes that prices will eventually decline?
The recent run-up in oil prices is evoking a big increase in investment in global production technology to boost recovery rates, exploration of new fields, increased pipeline and refinery capacity, and so on. The global oil system appears to have plenty of product in it. U.S. inventories today are at their highest levels since 1999, when the price of oil was less than $20. The world has seen wars, hurricanes and accidents in recent years, and has not experienced a single supply interruption. Yes, demand is growing, but the system is meeting that demand.
So, why are oil prices so high? Politics. From Venezuela to Nigeria to Iraq, Iran and Saudi Arabia, politics is dominating economics in driving oil prices. Probably the biggest political factor is in Iran: markets are transfixed by the possibility that Iran, the fourth-largest producer in the world, will shut off its own production, or act to disrupt the flow of others’ oil through the Straits of Hormuz.
At issue is Iran’s desire to become a nuclear power. U.S. efforts to contain Iran’s nuclear ambitions have given rise to a delicate diplomatic dance with numerous participants. In particular, India finds itself caught in the middle between its traditional energy supplier, Iran, with which India would like a formal long-term energy supply agreement, and its new strategic ally, the U.S. A way forward was opened through a renegotiation of India’s own nuclear parameters with the U.S. But that still leaves Iran and the U.S. in a deadlock, and oil prices locked in an uptrend.
So what comes next? Even if the political situation in the Middle East remains in limbo, there should come a point where markets realise that risk is not the same as reality. Each week that goes by with the oil market peacefully going about its business should reduce the risk premium that buyers are willing to pay for oil. The problem is that those buying the oil are not the ones that ultimately pay the higher costs are simply passed on to the consumer. However, if the situation persists, consumers will begin to conserve and even more supply will be forthcoming. In other words, oil prices should drift down economics should triumph over politics, eventually.
Even so, geopolitical moves by other players indicate that the global energy game has changed. Russia is flexing its energy muscles. China is shopping the world for energy assets, particularly in Africa. And South American producers are turning more nationalistic and assertive about controlling energy resources. This all suggests that even if oil prices drop significantly over the next 12-18 months, they might remain at lofty levels because of strategic buying.
The bottom line? There are a lot of implications stemming from this geopolitical game, but two stand out. First, even if oil prices ease to around $50, the Canadian petro-dollar will remain above US 80 cents. Second, with its new-found oil riches, Africa will become a much more prominent economic player and perhaps bring some welcome new competition into global energy markets.
Stephen S. Poloz, is Senior Vice-President, Corporate Affairs and Chief Economist, Export Development Canada. His column on trade-related issues appears weekly on www.ctl.ca